Forest Labs Seen Needing Deal Amid Patent Loss: Real M&A

Forest Laboratories Inc. (FRX) needs acquisitions to counter a projected 80 percent drop in profit this year as patents on its top-selling drugs start to expire.

About three-quarters of the company’s more than $4.5 billion of sales last year were generated by the antidepressant Lexapro, which lost exclusivity in March, and Namenda, an Alzheimer’s treatment facing the end of its patent protection in 2015. Net income at New York-based Forest, where costs have risen faster than sales over the last five years, is projected to tumble the most in at least 16 years, according to analysts’ estimates compiled by Bloomberg.

With more net cash relative to its $9.5 billion market value than every other similar-sized specialty drugmaker in the U.S., Forest should use its $3.2 billion in cash and marketable securities to fund an acquisition that will give it new drugs to replace lost sales, according to Robert W. Baird & Co. and Piper Jaffray Cos. Forest, which is embroiled in a proxy fight with Carl Icahn, may find Salix Pharmaceuticals Ltd. (SLXP), the $3.2 billion maker of a treatment for travelers’ diarrhea, to be an attractive target, said Susquehanna International Group LLP.

“The pipeline, as currently constituted, is not nearly enough to replace the lost revenue from losing Lexapro and Namenda to generics,” David Amsellem, an analyst with Piper Jaffray in New York, said in a telephone interview. “I think that if they were to be more aggressive on M&A and not just look at one-off pipeline assets, but rather look at commercial-stage assets as well, and were more aggressive in using their balance sheet, that they can definitely get themselves out of the hole.”

Photographer: JB Reed/Bloomberg

Lexapro had $2.1 billion of sales last year, 46 percent of Forest’s total revenue. Close

Lexapro had $2.1 billion of sales last year, 46 percent of Forest’s total revenue.

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Photographer: JB Reed/Bloomberg

Lexapro had $2.1 billion of sales last year, 46 percent of Forest’s total revenue.

‘Strongest Pipelines’

“Forest already has developed one of the strongest pipelines in biopharma today, which we believe will more than offset the patent expirations of Lexapro and Namenda over time,” Forest said in an e-mailed statement. “We maintain an extremely active and disciplined business development program, enabling us to identify promising new product license and acquisition opportunities that will enhance our pipeline and portfolio even further.”

Forest last month cut its forecast for fiscal 2013, which ends in March, because Lexapro sales are being reduced by Teva Pharmaceutical Industries Ltd. (TEVA)’s generic version.

As a result, analysts are projecting Forest’s revenue this year will tumble 28 percent to $3.3 billion, the lowest annual level since 2006. The company will post net income of about $191 million, an 80 percent drop from fiscal 2012, estimates compiled by Bloomberg show.

Generic Competition

Generic versions of Namenda, its other top-seller, can enter the U.S. market starting in 2015.

“The patent expirations put them in a position of weakness,” Jay Singhania, a money manager at Dallas-based Westwood Holdings Group Inc., which oversees $13.9 billion, said in a phone interview. “They’re overleveraged to two products. They’re in a tougher spot than companies that have another base of earnings.”

Lexapro had $2.1 billion of sales last year, 46 percent of Forest’s total revenue. Namenda accounted for $1.4 billion, or about 31 percent, data compiled by Bloomberg show.

Of 104 drugs with U.S. patent protection expiring between 2012 and 2016, 44 percent will lose exclusivity this year and next, according to data compiled by Bloomberg. Companies from AstraZeneca Plc (AZN) to Bristol-Myers Squibb Co. (BMY) are now using their cash for takeovers to help replace the lost revenue.

Drug Takeovers

AstraZeneca, which will lose exclusive rights to two of its best-selling medicines by 2014, last month completed the $1.12 billion acquisition of Ardea Biosciences Inc. Bristol-Myers, which faces patent expirations for three of its top four drugs within three years, agreed last week to buy Amylin Pharmaceuticals Inc. for $6.5 billion, after earlier this year paying $2 billion for Inhibitex Inc.

Forest’s $3.2 billion in cash and marketable securities -- along with no debt -- is equal to about a third of its market value, a higher ratio than all 13 other specialty pharmaceutical companies greater than $1 billion in the U.S., data compiled by Bloomberg show.

“At some point, you’re going to see them use that balance sheet,” Gary Nachman, an analyst with Susquehanna in New York, said in a phone interview. “I don’t think what they have in their pipeline is enough.”

Salix, the maker of gastrointestinal treatments, may be one attractive target for Forest because its drugs could be marketed by the same sales force that will sell the irritable bowel syndrome medication that Forest is developing, he said.

Targeting Salix

Salix is the maker of Xifaxan, an antibiotic used to treat traveler’s diarrhea and reduce the risk of a rare brain disorder caused by liver failure. The drug had $372 million in sales last year and a study is being done to evaluate its safety and effectiveness as a short-term treatment for irritable bowel syndrome.

Representatives for Morrisville, North Carolina-based Salix didn’t respond to phone calls and e-mails seeking comment.

Shares of Salix fell 1.2 percent to $54.91 today, while Forest declined 0.3 percent to $35.48.

“We’re always looking” for acquisitions, Frank Perier, Forest’s chief financial officer, said on a Jan. 17 conference call. “We are looking for opportunities that can add significant incremental value to the overall earnings potential of the business.”

Forest’s focus on drugs marketed to primary care physicians has led to higher costs, according to Tom Russo, a Chicago-based analyst for Baird. Those medicines face more competition from generics and require more sales people to target a broad set of customers, versus selling more specialized medicines, he said.

‘Irresponsible’ Spending

Selling, general and administrative expenses at Forest have climbed 48 percent over the past five years, outpacing a 35 percent increase in sales, data compiled by Bloomberg show.

“We believe the company overspends in an irresponsible way,” billionaire investor Icahn, 76, said in a phone interview yesterday. General and administrative expenses are “way too high. They’ve got to get the costs down and the earnings up.”

“Consistent with our past commercial successes, Forest has been actively supporting the development and launch of our ‘next nine’ products, which we believe will more than offset the patent expirations of our legacy products,” Forest said in an e-mailed statement. “We believe this investment is prudent, necessary and fundamental to the growth of shareholder value.”

Icahn, Forest’s second-largest shareholder with a 9.9 percent stake, is pursuing a proxy fight against the company for the second year in a row. He has nominated four directors and last week sued for access to its books and records.

‘Theatrical Display’

This week, Icahn sent a letter to Forest Chief Executive Officer Howard Solomon accusing management of making “a savvy bet against” the drugmaker’s prospects by selling shares before Lexapro lost patent protection. Following Icahn’s July 2 statement that he would look into the stock sales, Forest issued a press release saying “we are not surprised by Mr. Icahn’s theatrical display of self-serving rhetoric, but his public rants do not serve any useful purpose.”

When asked whether Forest should pursue deals, Icahn said he’s concerned that “Solomon will swing for the fences, using company cash to make risky acquisitions.”

Forest already has other new drugs in the pipeline that can partially offset lost sales. An experimental medicine called linaclotide, used to treat irritable bowel syndrome and chronic constipation, may draw $500 million in sales by 2017, according to Nachman. In April, the U.S. Food and Drug Administration delayed its decision for possible approval of the drug until September. Forest also acquired the antidepressant Viibryd last year through the purchase of Clinical Data Inc., valued at as much as $1.2 billion, after the FDA approved the drug.

‘High Expectations’

“Management’s excitement and satisfaction with its five-year business prospects was tangible, and rightfully so,” Annabel Samimy, a New York-based analyst at Stifel Nicolaus & Co., wrote in a June 21 report. “Forest’s strategic approach was well planned and executed. We now turn our sights to commercial execution, for which we believe there are high expectations.”

Baird’s Russo says the drugs in the pipeline won’t be enough. Analysts on average estimate Forest’s stock will be valued at $35.59 a year from now, only 2 cents more than its closing price of $35.57 yesterday.

“Their two biggest legacy blockbuster products are going off patent in a short period of time,” Russo said. A sizeable acquisition “would be an appropriate strategy at this point.”

To contact the reporter on this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net; Meg Tirrell in New York at mtirrell@bloomberg.net.

To contact the editor responsible for this story: Sarah Rabil at srabil@bloomberg.net; Reg Gale at rgale5@bloomberg.net.

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